Fiscal cliff isn’t America’s worst money problem

Commentary: Take strong medicine now to cure toxic economic policies

By

SatyajitDas

Reuters

President Barack Obama and House Speaker John Boehner will try to reach a deal to avert the so-called fiscal cliff — the automatic federal spending cuts and tax hikes slated for Jan. 1 — just one of several major economic risks affecting investors.

SYDNEY (MarketWatch) — Going over the so-called fiscal cliff may, on the face of it, “improve” U.S. public finances, reduce the deficit and slow the rise of America’s debt mountain.

But the fiscal cliff will not of itself solve America’s large and deep-seated financial problems.

Absent political agreement, a series of automatic federal tax increases and spending cuts — the fiscal cliff — will be triggered on Jan. 1. Several temporary tax cuts will expire. These include President George W. Bush’s tax cuts on income, investments, married couples, families with children, and inheritances, which were supposed to expire in 2010 but were extended for two years by President Barack Obama.

Avoiding the fiscal cliff

(4:54)

The White House plans an aggressive public campaign to build support for its approach to reduce the deficit through tax increases and spending cuts. Photo: Reuters.

In addition, the Alternative Minimum Tax would affect up to 26-30 million middle-class Americans, whose tax bill would balloon by an average of $3,700 each.

Also, the payroll-tax cut of 2% and extended unemployment benefits for the long term unemployed (both implemented by the Obama Administration to stimulate the economy) would terminate, along with smaller tax cuts for individuals and business (most notably tax credits for research and development and a deduction for state sales taxes).

Meanwhile, automatic spending cuts will kick in, totaling about $600 billion per year and $6.1 trillion over 10 years. The spending cuts would affect most government programs, including a $55 billion cut in defense spending and $55 billion in domestic programs. Medicare, the federal health program for the elderly, would reduce payments by 2%, including a sharp reduction (as much as 30%) in reimbursements to doctors.

The automatic tax increases, non-renewal of tax cuts and spending cuts are equivalent to about 5% of GDP. In a recent report, the non-partisan Congressional Budget Office estimated that the tax increases and spending cuts would reduce output by around 3% and increase unemployment to 9.1%. Read more: MarketWatch's complete fiscal cliff coverage.

Negotiation and reform

Yet a decision does not have to be reached by the end of 2012. The Treasury can juggle its finances to buy time, perhaps until February, especially if an agreement is likely. The major constraint is the need to increase the government’s borrowing cap or debt limit (currently $16.4 trillion), which will be hit before year-end or early in 2013.

Necessary reform of the tax system, especially a broadening of the tax base, and all spending, including social welfare programs, is unlikely to be easy.

President Obama’s ability to implement policy is constrained by Republican control of the House of Representatives. Republicans are reluctant to entertain tax increases or reductions in exemptions. Democrats are reluctant to consider reductions in entitlements and spending. Read more: Kicking the fiscal can has advantages.

The president asserts that he has a mandate to reform the budget, particularly to increase taxes on wealthier Americans. Having lost the presidential election and also having failed to make hoped-for gains in congressional elections, Republicans are defensive. The GOP position is complicated by fractious internal politics. More conservative elements believe GOP presidential candidate Mitt Romney lost due to a shift to centrist policies, and that a return to more strict conservatism is required.

Satyajit Das

Republican House Speaker John Boehner has been conciliatory to the administration, signalling a willingness to consider some higher taxes. In the fissiparous world of U.S. politics, nothing is guaranteed, especially given the short electoral cycle. The prospects for a definitive, so-called grand bargain remain poor. The more likely scenario is an incremental, ground-game strategy. Read more Das commentary: Financial WMDs debase U.S. dollar, risk inflation.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information. Intraday data
delayed per exchange requirements. S&P/Dow Jones Indices (SM) from Dow Jones & Company, Inc.
All quotes are in local exchange time. Real time last sale data provided by NASDAQ. More
information on NASDAQ traded symbols and their current financial status. Intraday
data delayed 15 minutes for Nasdaq, and 20 minutes for other exchanges. S&P/Dow Jones Indices (SM)
from Dow Jones & Company, Inc. SEHK intraday data is provided by SIX Financial Information and is
at least 60-minutes delayed. All quotes are in local exchange time.